FROM WELFARE TO WORK IN ONTARIO: STILL THE ROAD LESS TRAVELLED

Executive Summary

A few years ago, TD Bank Financial Group laid out a goal for Canadians: to raise the country’s standard of living above U.S. levels within 15 years. In 2002, the bank hosted the TD Forum on Canada’s Standard of Living, which brought together Canadians from all walks of life to develop practical suggestions for how to translate the standard of living challenge into reality. And, in support of that goal, TD Economics has produced a series of reports on the issue, focusing on the needs of Canada’s urban areas – the locus of economic activity and population growth in the country, and the main battleground where the standard of living challenge will be won or lost.

One issue that has cropped up repeatedly in our research is the importance of developing a more effective and equitable income transfer system – one that does a better job of bringing disadvantaged individuals into the economic mainstream. In 2004, the Toronto City Summit Alliance and St. Christopher House launched a task force devoted to this goal. The Task Force on Modernizing Income Security for Working Age Adults (MISWAA) is seeking to identify failings in the present income security system and lay out a road map for change – objectives that mesh well with the TD standard of living challenge. TD is a member of the MISWAA Task Force and has conducted this background study to assist the Task Force with its deliberations and provide insight into the policy recommendations it is considering.

The argument for focusing on working age adults

Canadian governments have made great strides in recent years in improving the financial security of society’s oldest and youngest members. Ongoing enhancements to Old Age Security, the Guaranteed Income Supplement, and the Canada/Quebec Pension Plans have gone a long way toward shoring up the finances of older Canadians, and the 1998 National Child Benefit initiative is doing the same for low-income families with children. But, alongside these gains, there has been a steady erosion in income support for working age adults. In the face of an increasingly challenging labour market environment, marked by stagnant wage growth and an increase in temporary and non-standard work, a reduction in the share of the labour force covered by the federal government’s Employment Insurance (EI) program has left unemployed adults with fewer resources to fall back on when they lose their jobs. And, no one has been harder hit than those forced to turn to social assistance, after a decade of cuts to welfare delivered by provincial governments intent on trimming deficits.

That was certainly the case in Ontario, where the Harris government introduced a radical overhaul of the province’s welfare system over the 1995-2000 period. One of the key features of that restructuring was the introduction of workfare, an initiative whose stated purpose was to strengthen welfare recipients’ attachment to the labour force – and, the inspiration for the program’s new moniker, Ontario Works (OW), which it bears today. Consistent with this shift in emphasis, OW recipients were required to “earn” their benefits by participating in community placement or training programs that were meant to function as a bridge into more permanent employment. And, to sharpen the incentive to make this transition, eligibility requirements for welfare were tightened and benefits for the non-disabled were slashed by a sizeable 21.6 per cent.

The government defended the measures on the grounds that they would help nudge more adults off welfare and into workforce, thereby laying the groundwork for a more enduring solution to the problem of poverty. But, while welfare caseloads in Ontario did fall in the ensuing years, a closer look at the data suggests that one of the main drivers of the decline was fewer Ontarians being able to get on welfare – not the intended exodus of welfare recipients into the workforce. In addition, the drop in caseloads has since levelled off, holding steady at around 200,000 households so far this decade. That is all the more striking in view of the fact that welfare allowances in Ontario have fallen substantially, in nominal and real terms, since Ontario Works was launched ten years ago. Based on the usual arguments, this should be serving as an increasingly powerful incentive for OW recipients to find work, to supplement an income that is becoming less adequate with every passing year. Yet, that is not what is happening. As of December 2004, less than 13 per cent of OW recipients had any kind of attachment to the labour force.

Economic arguments for bringing adults into the workforce are compelling

This poor employment outcome is all the more discouraging, given the fundamental soundness of the principle underlying Ontario Works – namely, that people who can work should work. Working has been shown to be one of the surest routes out of poverty for low-income adults, and what is good for individuals is also good for society as a whole. Over the long term, a system that brings more working age adults into the workforce, where they can earn their own income and develop greater economic self-sufficiency, will see welfare costs fall. That, in turn, will free up resources for other things, like lowering personal and corporate income taxes, reducing debt, and financing new investments in health care, child care, education, and research and development – all of which boost productivity and raise living standards for everyone.

Moreover, the costs of not acting are high and rising. Canada’s elderly dependency ratio – the ratio of working-age adults relative to adults aged 65 and older – has already declined substantially, and will fall further in the coming years, as the population ages. One of the best strategies for ensuring the long-term health and sustainability of income security programs that Canadians value so highly, like the Canada Pension Plan, Medicare and Old Age Security, is to bring all eligible working age adults into the workforce as soon as possible. This is true across the country, but particularly in Ontario, where changes in the way that income security programs are funded and delivered mean that municipal governments face a serious financial crunch during the next economic downturn. The pinch will be especially painful in Toronto, where the share of the unemployed population receiving EI benefits is well below the national average.

Barriers to work and marginal effective tax rates

Given the obvious symmetry of individual and socioeconomic interests served by greater labour force attachment among working age adults, Ontario Works’ focus on promoting employment among adults who can work has obvious merit. But, it’s equally clear that something has gone awry along the way – and, we needn’t look far to find the source of the problem.

The fact is that, even when the real value of welfare allowances is substantially reduced, the structure of most welfare programs gives recipients little financial incentive to get off social assistance. That’s because people lose cash and non-cash benefits when they exit welfare, and incur a host of new work-related expenses, that their employment earnings often aren’t sufficient to cover. This can leave them no better off, or even worse off, as a result of taking a job. These kinds of ‘barriers to work’, as they are sometimes called, can contribute to a low-income trap, in which individuals are unable to complete the transition off welfare, despite struggling to make ends meet on what is generally a subsistence income.

It’s important to recognize that this is not a problem that can be completely resolved. To keep the income security system affordable, needs-tested benefits like welfare have to be scaled back as recipients’ incomes rise. But, the phase-out inevitably raises marginal effective tax rates – i.e., the share of each additional dollar of earned income that is lost to higher taxes and forgone transfer payments and services – limiting the gains that people realize from earning extra income. Still, while the trade-off can’t be eliminated, better program design can mitigate some of its worst aspects.

In August 2005, the McGuinty government set out to do just that, by introducing a new set of rules for Ontario Works. In the body of this paper, we look at the impact of those changes on a couple of hypothetical welfare recipients in the province, to see how well the new rules live up to their stated purpose of helping OW clients make a ‘permanent and successful transition into the workforce’. On balance, we can’t give the total package a high grade. But, it’s fair to say that the new rules do largely accomplish what they set out to do – reduce barriers to work – and that most, though not all, of the problems that still afflict the program are directly related to deeper failings in the rest of Canada’s income security system.

More clarity needed regarding welfare’s proper scope

It’s essential to have realistic expectations about what a welfare program can and cannot do. A good place to start is by recognizing that welfare recipients have two separate, but inter-related problems. One has to do with the high marginal effective tax rates they face, which limit the gains they realize from working. The other has to do with the level of their income at any given point along the welfare/work spectrum, which is invariably low, and almost certain to fall short of meeting their needs.

Remedies to the first problem can be sought within the welfare system, but the second requires broader-based solutions. There are two reasons for this. First, if one of the goals of a welfare program for working age adults is to promote work, then it follows logically that the benefits provided cannot be adequate to meet recipients’ needs, because if they were, it would reduce the relative attractiveness of work. Second, the problem of low income is clearly not confined to the welfare system. Many adults today cannot earn enough to feed their families, pay for childcare, and cover a variety of other expenses, despite having a significant attachment to the labour force – and, no association with welfare.

No amount of tinkering with welfare rules can solve the latter problem. Rather, complementary measures are needed to boost after-tax incomes at the low end of the income scale, to reduce the pressure on welfare, as well as to ensure that individuals who cannot or will not access the system have other resources to draw on.

Rating the new Ontario Works

From this perspective, how do the new Ontario Works rules measure up? On the main count of doing more to ‘make work pay’, the new rules must be seen as an improvement over their predecessors, delivering a measurable reduction in the marginal effective tax rates that OW recipients face as they seek to work their way off welfare. This was one of the principal criticisms of the old system, with welfare recipients facing marginal effective tax rates of 100 per cent or more at most stages along the welfare/work spectrum – giving them virtually no incentive to boost their market income. With a marginal effective tax rate of more than 100 per cent, welfare recipients forfeit more than one dollar in income and benefits for each additional dollar they earn. It’s hard to imagine a more powerful disincentive to leaving welfare for work. Indeed, seen from this angle, the fact that any OW recipients at all seek work speaks to a keen desire to improve their living standards.

The structure of the new earnings exemption introduced in August 2005, which lowers the taxback rate on employment income to 50 per cent from 75-100 per cent, goes a long way toward easing this problem. So, too, does a temporary extension of OW drug and dental benefits for recipients leaving welfare for work. This makes the ‘welfare wall’ at the OW exit point a little more permeable. Yet, overall, the improvement is still modest. Even with the changes, welfare recipients in Ontario still face marginal effective tax rates of well over 50 per cent. And, while the spike in these rates associated with the loss of the OW drug and dental benefits has been deferred, it has not been eliminated. Once those benefits run out, OW recipients will still sustain a hit to their disposable income of roughly $1,500 – roughly the annual value of the extended health benefits provided by Ontario Works – for earning just a few more dollars of market income.

Pros and cons of lowering taxback rates

Moreover, the reduction in marginal effective tax rates itself does not come without a price. By lowering the taxback rate on employment earnings, the August 2005 rules also raise the earnings threshold at which existing OW clients become ineligible for benefits. This is the basic mechanism of an income-tested benefit – but if the arithmetic is straightforward, evaluating the consequences is not. As a result of the lower taxback rate, most OW recipients will end up with a higher disposable income in the present, because a smaller share of their employment earnings will be clawed back for a given level of market income. But, the flip side of this is that the level of market income they need to attain to exit welfare – sometimes called the ‘break-even level’ – has been raised.

This is very much a mixed blessing. The reality is that, for the most part, life on welfare is a precarious and demoralizing existence. The rules governing the system are complex and opaque. The application process is cumbersome, and once recipients are approved, they face regular monitoring and supervision by caseworkers. Cash allowances are based on a monthly needs test, which is linked to recipients’ earnings, meaning that benefits can vary each month with fluctuations in work income – making planning for the future very difficult. And, harsh restrictions on assets make it difficult to build up a pool of savings.

As a result, hard questions need to be asked about whose interests are really served by restructuring welfare benefits in such a way that recipients’ association with the system is prolonged to any degree. As we argue in the body of this paper, the rise in break-even levels for single adults is a price worth paying, because it goes hand in hand with a cash allowance, and thus a disposable income, that is still very low in dollar terms. However, because parents on welfare start with a much higher monthly allowance, the same reduction in the taxback rate on their employment earnings pushes up their break-even levels much higher – so high, in our view, that it works at cross-purposes to the goal of helping families get off assistance.

That said, the fault cannot be laid at welfare’s door. The higher break-even levels are necessary, largely because low-income parents have few places to turn for their child care needs – forcing OW to compensate by providing more generous benefits for parents. But, this has ripple effects throughout the system. It diverts more of OW’s supports to parents, leaving fewer resources available for single adults at substantially lower levels of income – in many cases, a more obvious ‘target market’ for welfare.

In drawing attention to this differential treatment of household types within OW, we do not mean to suggest that low-income parents do not deserve help with the cost of raising their children. Rather, our point is that the welfare system is the wrong vehicle for providing this kind of support. Welfare can and should be reformed to improve work incentives for social assistance recipients. But, it was not meant to be a substitute for a broader set of social policies, aimed at meeting needs ranging from assistance with employment, to income supplementation when work doesn’t pay enough, to sundry health benefits and child care. When the welfare system is pressed into service in this way, no one is well served by the result.

Comprehensive approach means tackling welfare, and the world beyond

A strategy to improve the income security of all low-income adults will require further modifications to both welfare and non-welfare programs. On the welfare side, the August 2005 Ontario Works rules have helped lower barriers to work for welfare recipients, but there is still room for improvement in other parts of the system.

• Asset limits: One area that stands out in particular – and which received no attention with the August 2005 rule changes – is the asset side of the equation. At present, OW clients are permitted to accumulate savings equivalent to only 1-2 months’ worth of their monthly cash allowance.

  This is a significant omission, for two reasons. First, in general terms, it is at odds with a growing appreciation in the financial community for the critical role that assets play in cushioning families through temporary disruptions in income. Second, it sits awkwardly with the decision to lower the taxback rate on employment earnings, which raises the earnings threshold at which OW recipients lose their eligibility for assistance. With no commensurate increase in the asset limits, the implication is that recipients have to spend all of the additional income they earn. This suggests that the OW architects have paid insufficient attention to the need to enhance opportunities to save – surely an important corollary to promoting incentives to work.

But, if a clear case can be made for raising asset limits, to give people room to build up enough savings to make abandoning OW’s cash and non-cash benefits a viable option, that is the only additional reform that Ontario Works can be expected to make on its own. The remaining flaws in the system arise from situations where welfare has had to expand beyond its natural domain of providing short-term income support into offering broader forms of assistance. As such, these flaws cannot be corrected without supporting changes in the rest of the income security system.

The TD report raises several ideas for consideration that MISWAA Task Force is considering as it proceeds with its efforts to develop a road map for change:

• A working income supplement and refundable tax credit for low-income Canadians: One of most pervasive needs is to tackle the problem of poverty among people on and off welfare. Raising welfare allowances to help the former group is not the answer, because it reduces the relative attractiveness of work. And, substantially hiking the minimum wage over and above the increases already planned risks labour market repercussions. Two options that some jurisdictions in Canada have already had success with, albeit on a smaller scale, are a working income supplement and a refundable tax credit for low-income adults.

  Neither solution is perfect. There would be a net cost to whichever level of government provided the benefit, and because both measures would need to be income-tested, they would raise marginal effective tax rates over some range of income. But, if properly designed, the two measures collectively would help take some of the pressure off welfare to shore up the financial security of low-income adults. And, they would have the virtue of doing so through anonymous, rules-based programs that are free of the stigma and intrusive administrative oversight that go along with discretionary programs like welfare.

• Completing the National Child Benefit (NCB) initiative: The 1998 NCB initiative offers provincial and territorial governments an opportunity to use the federal NCB Supplement as a platform for developing an integrated, income-tested benefit for Canadian children that would eventually replace welfare-based child benefits. Ontario has taken a step in that direction with the introduction of the Ontario Child Care Supplement for Working Families (OCCS), but the program serves only a small segment of the low-income population – namely, low-income families with children under the age of 7. That leaves a healthy chunk of income support for low-income children in Ontario to be paid through the welfare system. As a result, OW has to pay parents a substantially higher allowance than it pays single adults, and this produces a number of distortions in the work incentives and opportunities available to these two household types. Completing the NCB initiative would eliminate the source of these distortions, enhancing OW’s ability to function as a temporary income support program that provides genuine and fair work opportunities to all recipients.

• Employment Insurance (EI) reform: A decline in the share of the unemployed population covered by the federal government’s EI program has left low-income adults with fewer resources to fall back on when they lose their jobs. This has put more pressure on provincial welfare systems, and many have responded by raising entry barriers – chiefly, by imposing disqualification periods during which earnings exemptions that existing clients can claim are denied to new applicants. The result is a growing problem with horizontal inequity, where two households with similar financial profiles end up in very different economic circumstances, because one has access to all the supports of OW and the other doesn’t.

  It is possible that reforms to EI implemented in the 1990s may have gone too far in raising hours of work requirements, particularly in areas with low unemployment rates. But, there is good reason to believe that the problem is related more to shifts in the composition of the labour force that the present EI system is ill-equipped to deal with. A rising trend toward self-employment, and an increase in the number of recent immigrants who have no prior work experience in Canada – two groups who would have been ineligible for EI benefits even prior to the 1990s rule changes – stand out as obvious examples. Complementary, stand-alone programs might be of some use in addressing this problem, to ensure that individuals who are not eligible for direct unemployment insurance do not also lose out on related services, like assistance with skills development and training. If unemployed adults were better served by EI or related programs, there should be correspondingly less need for provincial governments to keep entry barriers to welfare so high that they risk denying access to people who are legitimate candidates for social assistance.

Gillian Manning, Economist
416-982-2559

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